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25.11.10

With the recent crisis, the East asserted with increasing confidence that their system was superior than the West: Societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of achieving overall net gain, take charge of their economics, and sacrifice short run consumer interests for the sake of growth would eventually outperform the increasingly chaotic societies of the West.

Before turning to Asian growth, it may be useful to introduce the concept of growth accounting and review some important pieces of economic history. Economic expansion represents the sum of two sources of growth: (1) increase in inputs – growth in employment, in the education level of workers, and in the stock of physical capital (2) increase in productivity – may result from better management or better economic policy, but in the long run, it is primarily due to increase in knowledge. The growth accounting can tell us how much of growth is due to each input – say capital as opposed to labor and how much of it is due to improved efficiency.

Now, let’s turn to the example of rapid Soviet economic growth four to five decades ago. It was one of the wonders of the world. Official soviet growth numbers were consistently being criticized. Nonetheless, Soviet claimed that the astonishing achievement was fully justified: their economy was achieving a rate of growth twice as high as that attained by any important capitalistic country over any considerable number of years and three times as high as the average annual GDP growth rate in the US by the early 1970s. When economists began to study the growth of the Soviet economy by using growth accounting, they actually found that Soviet growth was based on rapid growth inputs, rather than efficiency growth. By some estimates, the efficiency growth was almost nonexistent. The Soviet moved millions of workers from farms to cities, pushed millions of women into the labour force and millions of labours into longer hours, pursued massive programs of education, and plowed the ever-growing industrial output back into the construction of new factories. Soviet rapid expansion did eventually come to an end.

It is hard to see anything in common between the Asian success stories of recent years and the Soviet Union five decades ago. Indeed, it is safe to say that a typical business traveler flying into Singapore’s remarkable harbour with thousands of cargo boats in endless lines off the coast, never even thinks of any parallel to its roach-infested counterpart in Moscow. How is this Soviet example relevant to the modern world? Yet there are surprising similarities. The newly industrializing countries in Asia, like Soviet Union of the 1950, have achieved rapid growth in large part through an astonishing mobilization of resources, rather than by gains in efficiency.

Singapore grew through a mobilization of resources. Some statistics show that its productivity growth has been very much flat in the past few decades. Of course, Singapore today is far more prosperous than the Soviet when it was at its peak, because Singapore is closer to, though still below, the efficiency of Western countries. The point, however, is that Singapore’s economy has always been relatively efficient, it just used to be starved of capital and educated workers.

Singapore’s case is admittedly the most extreme. Other rapidly growing East Asian economies have not increased their labour force participation as much, made such dramatic improvements in education levels, or raised investment rates quite as far. Nonetheless, the basic conclusion is the same – there is little evidence suggesting improvements in efficiency.

What about Japan and China? Japan, unlike the East Asian tigers, seems to have grown both through high rates of input growth and through high rates of efficiency growth. Today’s fast growing economics are nowhere near converging on the US efficiency levels, but Japan is staging an unmistakable technological catch-up. However, for China, it is still a relatively poor country by GDP per capita standard. Its population is so huge that it will become the next economic power if it achieves even a fraction of Western productivity levels. And China, unlike Japan, has in recent years posted truly impressive rates of economic growth. Back to growth accounting, it is unclear what year to use as a baseline for the growth assessment in China. If one measures Chinese growth from the point at which it made a decisive turn toward the market, say 1978 Mao Zedong’s later years, there is little question that there has been dramatic improvement in efficiency as well as rapid growth in inputs. If one measures growth from before the cultural Revolution, say 1964m the picture looks more like the East Asian “tigers” – only modest growth in efficiency, with most growth driven by inputs.

If growth in East Asia is indeed running into diminishing returns, it is likely that growth in East Asia will continue to outpace growth in the West for the next decade and beyond without improving efficiency, but it will not do so at the pace of recent years. Going forward, the next priority on the list for Asian nations is to focus more on the long term sustainability of their economies, rather than the short term gains. To achieve this, investments in education, infrastructure, social benefits, technology and higher-value industries will have to be increased. The good news is, technology now increasingly flows across borders, and that newly industrializing nations are increasingly able to match the productivity of more established economies within a much shorter period of time. Diffusion of technology will place huge strains on Western world as capital flows into the emerging world and imports from these nations undermine the West’s industrial base.

If there is a secret to Asian growth, it is simply deferred gratification, the willingness to sacrifice current satisfaction for future gain.

~ Summary of Paul Krugman's "The Myth of Asia's Miracle" article from MIT